South African mining sector – the need to stage a comeback

Around the time of last year’s Mining Indaba, there was very little good news to share about the state of the South African mining industry. The global mining crisis had taken a heavy toll, particularly in bulk commodities like iron ore, manganese, chrome and coal. As a result, significant head-count cuts (such as at Kumba) were required to simply survive, and several companies were either in business rescue or liquidation. Many capital projects were trimmed or completely shelved – the mining industry pretty much had lost all momentum.

Henk de Hoop

At the beginning of 2016, there were few signals pointing to better financial fortunes in the year ahead. Yes, the Nenegate debacle in December 2015 had provided a significant and unexpected boost to rand revenues for most, but the outlook for a recovery in US dollar pricing remained grim.

But an unexpected boost to the industry came in the form of the Dragon. China, by far the largest global consumer of many commodities after two decades of exceptional economic growth (now consuming approximately 50% of the world’s copper, zinc, aluminium, and iron ore) started to pull some of its huge economic levers. The combination of creating renewed property market momentum, additional infrastructure spending and finally making the hard capacity curtailment decisions in its huge steel industry, caused steel prices to stir.

What followed during 2016 ended up wrong-footing almost all industry experts. A spectacular rally in steel-related commodities commenced – iron ore, manganese, chrome, zinc, coking coal all saw price increases that brought back memories of the 2006-2008 ‘glory’ days. It is important to highlight how big a turnaround this triggered in the fortunes of many South African mining companies involved in those sectors. Some manganese juniors were either in business rescue or on the brink at the beginning of 2016. Towards year-end some of these companies had made sufficient cash to be able to pay out R1bn plus dividends.

China was also the cause of another big commodity turnaround that commenced last year – thermal coal. Producers globally had already suffered several years of declining prices, which, combined with years of ‘bad publicity’ linked to its role in global warming and a pro-active divestment campaign, had made coal, in the eyes of many, a ‘doomed’ and declining industry. China’s tinkering with its huge domestic coal industry (for comparison, China produces some 3.5 billion tonnes per annum; South Africa only around 0.25 billion tonnes), related to closure and consolidation of capacity, as well as reducing the amount of working days for the rest of the industry, caused shortages, putting strain on international market pricing. Within months, thermal coal moved from marginal pricing in the 40 dollars/tonne range to over 100 dollars/tonne for a brief period, catching even the most experienced trading houses offside.

It is no surprise that the companies producing the goods saw spectacular price moves on the stock exchanges, again, wrong footing many industry experts and portfolio managers. In fact, according to some broker research, due to years of cost cutting, operational optimizing, selling of marginal assets, and capex curtailment, several major mining companies are producing larger cash flows now than at the time of the even higher prices of the previous boom.

With the exception of the platinum group metals (PGM) industry, 2016 price moves have caused a definitive positive change in sentiment in the mining industry. From years of inward looking to keep the ship afloat at all costs by cost cutting, capex curtailment, and divestment, companies are becoming more outward looking again. Balance sheets have stabilized, and in some cases, have become cash flush, which has rebuilt some of the confidence for corporates to consider growth again.

Although it is considered unlikely for much further upside momentum in most of the commodities mentioned (Trump’s infrastructure rebuild promises can boost sentiment, but the US percentage of global demand of certain of the commodities mentioned is a surprisingly low 7-9%), few believe prices will soon touch the lows again seen in 2015 either.

This time around, South Africa has an opportunity to be better prepared for positive sentiment towards the mining industry. Infrastructure constraints and policy confusion/frustration caused major damage to expansion opportunities offered in the 2000-2008 boom, something which should have taught the industry, labour, regulators, and policy makers some hard lessons. At least, some of the constraints have seemingly been addressed, or are being worked upon. Eskom’s worst capacity constraints are seemingly behind us (although cynics would say one of the reasons is because its steep price increases forced a portion of the heavy power consuming smelting industry to shut down/go out of business or relocate), while Transnet has created credible momentum in removing volume constraints on the iron ore, manganese and coal export linkages.

South Africa desperately needs to see a return to job-creating growth. The mining industry still has significant potential as an important catalyst to help achieve this.

It is therefore a potentially very damaging move, to see industry and government enter into a Mining Charter policy fight, rather than collaborative engagement focused on building upon the fragile foundation that has been laid by the price and currency driven revenue recovery seen over 2016.

Henk de Hoop, Business Development Director Resources at Rand Merchant Bank.